When out seeing clients, we are often asked our views on property, which in almost all cases seems to mean, “what is our view on UK bricks and mortar property funds?”. In practice, this is an area we do not consider. The reason for this is quite simple- these can be highly illiquid, and liquidity is a core part of our process. As genuinely active fund managers we like to be able to move when conditions change.
This is not to say we cannot use property as an important source of diversification in our portfolios. Property, like equities and bonds, is driven by its region’s economic and interest rate environment but often performs in ways that provide an important diversification benefit. Its primary attraction is that it provides an income stream, which should grow over time. Rents are driven by nominal economic output in the very long-term, but are much less volatile than company profits, which drive equity returns. Hence, property should provide lower volatility than equities. At the same time, unlike bonds, it provides an inflation hedge. When inflation rises, bonds yields tend to rise, leading to capital losses. Property, being partly driven off bond yields, might also fall as yields rise were it not for the fact that inflation driven rises in rents act as a compensating factor. Overall, this gives a nice balance, attractive reliable income streams like bonds, but inflation protection like equity, with volatility lower than mainstream equity.
We gain our exposure to property via Real Estate Investment Trusts (REITs), which are closed-ended property vehicles traded on the stock market. This gives us good daily liquidity but, for two reasons, they can be more volatile than the open-ended funds. The first reason is because of that liquidity, the market is able to re-value them instantly, rather than waiting for professional valuers to produce a monthly valuation. This means that REITs can become over and undervalued, providing opportunities, but mainly means they are more sensitive to changes in the market’s view of the outlook. The other reason they are more volatile is more fundamental: REITs often take more risk, in terms of borrowing to gear up returns and taking on development opportunities. For us, liquidity trumps volatility every time, as volatility evens out over longer periods but the inability to sell can cause real problems.
Another aspect of REITs is that we can be both more focussed on subsectors and diversify internationally. This gives us a much greater universe of potential property opportunities to consider. These range through subsectors, such as specialist distribution property, benefitting from the growth of online shopping, through to London West End focussed businesses that benefit from the growth of international tourism. At the same time, we can also avoid areas of potential weakness such as mainstream retail property, which has been suffering from the growth of online shopping (as we can see from Arcadia’s recent rent renegotiations).
Outside the UK, a wealth of opportunities open up, particularly when we consider property’s particular risk/reward characteristics. We use Japanese REITs for this reason. The Japanese Yen is a classic risk-off currency, acting as a safe-haven in uncertain markets, so we would like to hold Yen as a diversifier, however, Japanese bonds offer no yield whatsoever. Hence, we can hold Japanese REITs as a low risk Yen asset for diversification, while earning a positive dividend yield over time. We own South African REITs for very different reasons. Clearly the Rand is a riskier currency, but the REITs in South Africa have very attractive yields, which grow strongly in this relatively high inflation emerging market. Here we get lower risk emerging market growth exposure, which correlates very little with the rest of our portfolio.
Overall, REITs will likely always be an asset class we consider for our portfolios, given their attractive risk/reward characteristics and broadly diversifying nature. By being unconstrained and looking beyond the UK sector, we can find ways to better diversify our portfolios, whilst adding returns in the form of income or growth.
The value of stock market investments will fluctuate and investors may not get back the original amount invested.
The performance information presented on this page relate to the past. Past performance is not a reliable indicator of future returns.
For funds investing globally, currency exchange rate fluctuations may have a positive or negative impact on the value of your investment.
Forecasts are not reliable indicators of future returns.
Investments in emerging markets are potentially higher risk than those in established markets.